Comment

The Finance (No 2) Bill 2009 contains significant proposals with respect to the Indian transfer pricing provisions. These proposals contemplate easing the investment climate in the country and try to provide clarity on the provisions. A look at the more important proposals:

Introduction of safe harbours
The bill seeks to insert safe harbour provisions within the Income Tax Act, 1961. This would impact the computation of the arm’s length price, vis-a-vis international transactions, subject to certain pre-defined limits.Consequentially, where the pricing arrangement is found to be within the confines of the safe harbours so introduced, it will be accepted as meeting the arm’s length test.

The introduction of safe harbours is common practice in some advanced countries (for example, Australia for non-core services) as well as in developing nations (like Brazil and Mexico) and has been known to ease compliance pains to a large extent.

Such safe harbours will reduce judgment errors in determining transfer prices.From a taxpayer’s point of view, safe harbours will provide certainty over transfer pricing arrangements and help avoid protracted litigation with the revenue department.

The form and manner in which safe harbour regulations will be introduced remains to be seen.

Clarifications as regards +/- 5% range
A common cause of litigation between taxpayers and the revenue department is related to the applicability of the +/- 5 % bandwidth allowed for the computation of the arm’s length price. The revenue department holds that the benefit of the bandwidth should be given only where the taxpayer’s transaction price is within the +/- 5% range of arm’s length price. Taxpayers argue that the benefit should be allowed even when the transaction price fell outside this range.

To put an end to this dispute, the bill seeks to clarify the position over the benefit by proposing an amendment that in cases where the variation between the arm’s length price and transfer price of taxpayer doesn’t exceed 5%, the taxpayer’s prices shall be deemed the arm’s length price.

This would have the effect of disallowing the benefit to taxpayers where variation between the arm’s length price and transfer price of the taxpayer doesn’t exceed 5%.

Importantly, this amendment is sought to be introduced from October 1 and would impact all open assessment as on that date. However, the benefit of the +/- 5 range, even where the transactional price falls outside the arm’s length price, should apply to cases before this date.

Introduction of dispute resolution mechanism
With a view to expedite the time period within which the present appellate structure corrects conservative transfer pricing positions taken by the revenue department, the bill proposes the introduction of a Dispute Resolution Panel, comprising three income tax commissioners.

In cases involving foreign companies and those where transfer pricing adjustments have been made and are prejudicial to the taxpayer, the assessing officer needs to forward a draft order to the assessee.Based on such draft order, the assessee can file objections to the panel.

After considering all evidence and objections and further enquiries, the panel is to issue binding directions to the assessing officer within 9 months to pass the assessment order.

Orders passed on the basis of panel’s directions are to be directly appealed before the tribunal (not to the commissioner-appeals).
The amendments proposed in the bill were necessitated by the experience of the revenue department in transfer pricing assessments over the last decade.

What remains to be seen is how they are implemented and whether they will achieve what they have set out to.

The proposals
Introduction of safe harbours in the Income Tax Act, 1961, which
will impact the computation of the arm's length price, vis-a-vis
international transactions, subject to certain pre-defined limits

Clarifications as regards +/- 5% bandwidth allowed for the computation of the arm's length price

Introduction of a dispute resolution mechanism

The author is executive director, PricewaterhouseCoopers.
Views presented herein are personal and do not necessarily reflect those of the firm